The case for emerging markets fixed income amid improving global growth

We believe global macro conditions and a shift in central bank frameworks have set the stage for a sustained outperformance of emerging market (EM) assets over the next two to three years.

Global growth is expected to accelerate in the next few years, aided by the massive fiscal policy response in developed economies and some EMs. The changing policy framework at the US Federal Reserve (Fed), in particular, should ensure that US financial conditions remain favorable for a sustained, positive EM cycle. And while we consider the most influential policy change to be in the Fed’s framework, we expect policies of all major developed market central banks to support the EM asset class for the foreseeable future.

_{Global growth and its implications for EM}

We expect global growth to improve significantly in 2021, as recovery gains momentum after the virus-induced economic collapse in Q2 2020. While second and third waves of COVID-19 have reduced our near-term growth forecasts, as some countries will likely post contractions in Q4, our forecasts for next year and beyond have not changed significantly. Our forecasts assume the availability of at least a partially successful vaccine by Q1 2021, and they could be revised upward if the efficacy and uptake of the vaccine is very high.

The major factor underlying our expectations is the Fed’s new policy framework that should prevent US financial conditions from tightening as growth expectations improve. Going forward, growth differentials between the US and other countries will likely matter less for aggregate EM performance than they have in the past, as the market will likely not reprice the Fed’s path as growth picks up. We believe this is the most significant differentiator for the upcoming cycle when compared to the 2013 taper tantrum and the 2018 tax and budget deal. In the current environment, we expect improving global growth, whether driven by the US, other developed markets or EM, to be net-positive for EM assets and investment flows.

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